Are Chinese Stocks in a Bubble? Probably

Not many would argue that Chinese stocks are on fire. The Shanghai Stock Exchange Composite Index increased by 149% over the past year. The Shenzhen Stock Exchange Composite Index rose 190% during the same time period.

China’s equity market has achieved red-hot status just as the country’s economy goes through a cooling off period. This probably isn’t driven by sound economics either.

While it’s been common to see Beijing release annual GDP growth numbers above 10% over the past decade, economic growth in the world’s most populous country is at its weakest since the Great Recession in 2009 and expansion is expected to fall into the high 6% range in 2015.

The market carried higher by government stimulus and investor frenzy rather than fundamentals. This raises the question: is China in the midst of a bubble? If so, is it still safe to invest in China?

There are other growing indicators of speculative fervor in China. In recent years, people in the country sunk much of their excess savings into the real estate market.

However, the bubble in China’s housing market is now deflating. Capital has to go somewhere and it is piling into the skyrocketing stock market. Investors opened 4.8 million new stock trading accounts in March and then another million more in early April, according to the Financial Times.

“There’s no question there’s a lot of domestic euphoria about equities within China,” according to Albert Brenner at People’s United Wealth Management.

Chinese Stocks Are Traded “Just for Fun”

A poll by CNN Money revealed that retail investors trade Chinese stocks frequently in part to have fun, treating the act of investing less like a plan of long-term growth and more like a casino game.

Non-Chinese investors are along for the ride. Exchange-traded funds that track China —the most popular way for foreign investors to play China — have also soared. The iShares MSCI China ETF (MCHI) and SPDR S&P China ETF (GXC) are both up over 20% so far this year.

The liquidity pumped into the markets by rate cuts from China’s central bank is another ill omen. Part of this is because of the Hong-Kong Shanghai Stock Connect, which allows investors to buy Shanghai stocks through Hong Kong and vice versa, even though the program has been less popular than expected.

Despite all this, many are still bullish. Goldman Sachs does not seem to be too worried about the current situation. Timothy Moe, co-head of macro research in Asia at Goldman Sachs, told CNBC the market “certainly is getting frothy” amid “very frenetic retail activity.” However, he does not yet see it as the “bubble that will crash the system”.

Investors such as them say that instead of enjoying the ride, people should stay away from the Chinese market altogether. “The problem with any bubble is if you try to bet against it, bubbles can become even more irrational. The herd mentality can essentially run investors over,” said Ankur Patel.

For those wanting to invest in Asia, it may be worth looking at nearby frontier markers rather than China. Just to the north, the Mongolian economy is booming. Myanmar and Cambodia are also great options.